Today the Federal Reserve raised interest rates by 25 basis points, halving the planned hike after bank meltdowns caused turmoil in the financial sector.
The central bank concluded its two-day meeting to announce a new target range of 4.75 to 5 percent, raising the rate by a quarter of a percentage point, the ninth consecutive increase since last year to combat painfully high inflation.
But the Fed hinted in its new policy statement that the historic campaign to deflate inflation may be coming to an end. “The committee expects that some additional policies may be appropriate,” the statement said.
The Fed dropped a phrase used in its eight previous statements that the committee believes “continued increases” would be appropriate. Wall Street responded positively to the news with the Dow Jones rising 46 points and the S&P 500 up 0.37%.
While this is the highest rate since September 2007, the Fed was expected to raise 50 basis points just two weeks before the collapse of the $200 billion Silicon Valley bank. Jerome Powell admitted that the Fed has “considered” stopping rate hikes altogether as a result of the banking crisis.
Jerome Powell, Chairman of the US Federal Reserve, arrives at a Senate Banking, Housing, and Urban Affairs Committee hearing in Washington, D.C., US, on Tuesday.
The inflation rate fell sharply from 9.1 percent in June to 6 percent in February. That’s still well above the 2.5 rate Fed officials would like — but it suggests that rate hikes are paying off.
“We considered that in the days leading up to the meeting,” Powell admitted.
However, he cited data on inflation and jobs which “came in stronger than expected” meaning it could go ahead, albeit constrained.
We are committed to restoring price stability, and all evidence suggests that the public has confidence that we will do so which will bring inflation down to 2 percent over time. “It is important that we maintain that trust through our actions as well as through our words,” Powell said at the news conference.
The economy eased slightly in February, with the consumer price index, a closely watched measure of inflation, falling 0.4 points to 6 percent. It marks the lowest level since September 2021, but it’s still significantly off the Fed’s target and is causing massive hardship to households.
The collapse of SVB, the biggest banking failure since the Great Recession, led to wider chaos, including the demise of other regional lenders and global investment monster Credit Suisse.
Powell said management at SVB had “failed miserably” and exposed clients to “significant liquidity risk and interest rate risk”.
The chairman said tougher regulation was needed to stop another series of crashes. “My only concern is that we determine what went wrong here,” Powell said.
The Fed is walking a tightrope between continuing to raise interest rates to combat soaring inflation or applying the brakes to prevent further turmoil in the commercial banking sector.
Higher rates can undermine inflation by slowing the economy. But they raise the risk of a recession later, and they hurt stock prices and other investments.
This last factor was one of the reasons why SVB collapsed two weeks ago. And the prices of its bond investments have fallen as the Federal Reserve raised interest rates over the past year at the fastest pace in decades.
SVB also suffered from what is called a bank run, as its clients began withdrawing funds at the same time in a debilitating chain.
Since then, investors have been searching for what might be the next bank, and regulators around the world have been trying to boost confidence in the industry.
This graph shows the Fed’s interest rate through January 2023, with the Fed announcing the latest rate Wednesday morning
Prices for used cars and gasoline fell in February from a year ago, but prices for many basic necessities continued to rise at an uncomfortably fast pace
The February CPI number of 6% is the lowest annual inflation rate since September 2021
The worry is that excessive stress on the banking system, particularly among the small and medium-sized banks at the investor intersection, could mean fewer loans to businesses across the country.
This, in turn, could mean fewer hiring and less economic activity, increasing the risk of a recession that many economists see as already high.
The central bank may have been given wiggle room for another hike as equity and bank stock markets rallied this week after global financial authorities took measures to prevent contagion.
Despite making eight consecutive hikes since it began tightening monetary policy last year, prices have remained stuck above the Federal Reserve’s long-term inflation target of 2%.
However, the combination of hot economic data at the beginning of the year and uncertainty in the banking sector has most analysts expecting the Fed to continue a more moderate walking cycle than previously expected.
Today, the Fed also released its latest set of forecasts from policymakers on the direction of interest rates in the coming years. Median forecasts had the federal funds rate steady at 5.1 percent at the end of this year, up only slightly from where it currently is, in the 4.75 percent to 5 percent range.
This is also the same level we saw in December, and contradicts market concerns that it may rise given continued high inflation.
That helped send yields tumbling in the bond market, which has been home to some of the wildest action this month.
The yield on two-year Treasury notes, which tend to track the Fed’s forecasts, fell to 4.03 percent from 4.13 percent just before the forecast was released. It was above 5 percent earlier this week, and a drop of this magnitude in the bond market has been massive.
The yield on 10-year Treasury notes, which helps set prices for mortgages and other important loans, fell to 3.52 percent from 3.61 percent late Tuesday.
Last week, the European Central Bank pushed through with a massive hike in its key interest rate, despite speculation that it may back down given all the banking woes.
Christine Lagarde, its chairman, said on Wednesday that the way remains remarkably open and that it could raise interest rates further or pause depending on how conditions evolve.
What makes the decision so difficult for central banks is how strong inflation is despite sharp interest rate increases. It’s been down since last summer, but it’s still excruciatingly hot and it hurts the least affluent the most.
In the UK, a report showed that inflation accelerated for the first time in four months in February. This adds pressure on the Bank of England ahead of its interest rate decision on Thursday.
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